Investors and the Auditors of the Future

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Date

April 12, 2012

Speaker

Steven B. Harris, Board Member

Event

PCAOB Academic Conference

Location

Washington, DC

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Welcome to the 2012 PCAOB Academic Conference. The Board benefits significantly from your participation and we are delighted you are able to join us. At the outset, let me say that the views I express are my own.

Conversations with outside groups, like this gathering, are incredibly valuable to the work of the Board. And I think it is no secret to my fellow Board members that I am partial to two particular groups: investors and the auditors of the future — your students.

The Board was created to protect the interests of investors, so I believe it is vitally important that we listen to their concerns about the work of auditors and the work of the Board. But I also believe we owe it to future investors to encourage independence, objectivity and skepticism in the auditors-in-training today.

Because some of the topics may intersect with your current research and thinking, I want to take a moment to describe a few of the issues we have been hearing from our Investor Advisory Group. Agendas, slides and webcasts are available on our website if you want to explore any of these topics more deeply.

The Investor Advisory Group was created in July 2009 to provide a forum for the Board to obtain the views and advice from a broad range of individuals who have a demonstrated history of commitment to investor protection.

The group has met three times since its formation, with the most recent meeting being held last month on March 28. The topics that have been the subject of the most focus during these meetings include:

The auditor's reporting model;

Lessons learned from the financial crisis, including the need to strengthen the going concern auditing standard;

Audit firm transparency, including the identification of the engagement partner;

The role, relevancy and value of the audit; and

Auditor independence, objectivity and professional skepticism.

Last year, a sub-group of advisory group members, led by Professor Carcello, presented the results of a survey of more than 300 leaders of investment banks, mutual funds, pension funds, hedge funds, and private equity funds, who manage more than $7 trillion of assets.

Two points stood out in the survey results. First, investors want the auditor's report to discuss the auditor's assessment of the estimates and judgments used by management to prepare the financial statements. And, second, investors want auditors to discuss how they addressed the areas that presented the most significant risks that the financial statements might be materially misstated.

During the most recent meeting, members stressed that the going concern auditing standard needs to be overhauled, suggesting, among other things, that any new standard should include a clear objective for auditors to evaluate an entity's ability to continue as a going concern and design the audit to obtain evidence supporting their conclusion.

With respect to audit firm transparency, members believe that the audit profession should be subject to more transparency and accountability, including, for instance, holding an engagement partner more accountable for his or her own work and, at a minimum, identifying the partner in the auditor's report.

Last month, members reported on the results of another survey, which indicated that a sampling of investors think that rather than branching into new activities, the profession should stick to its knitting and continue to focus on improving audit quality. For example, investor representatives were generally not supportive of auditors expressing an opinion on the quarterly earnings releases or management's discussion and analysis. Rather, they encouraged the PCAOB to continue its efforts to enhance audit quality and develop a more informative auditor's reporting model.

Finally, during all three meetings, members have consistently urged the PCAOB to concentrate on improving auditor independence, objectivity and professional skepticism, citing the work by inspectors from the PCAOB and our non-U.S. counterparts that continue to identify audit failures resulting from insufficiently skeptical auditors.

In considering what we have heard from our Investor Advisory Group over the past three years, I was struck last week by a quote from Sir David Tweedie, the former Chairman of the International Accounting Standards Board, and a person generally recognized as one of the world's most influential accountants.

In a speech regarding the role of the auditor in the financial crisis, Sir David was quoted as saying:

"As we continue to shine a light into the debate, it should result in more of the good and detailed work of the auditor being reported to the true clients - shareholders and investors; more useful financial reporting and communication which tells the full story of a business and reflects economic reality; and regulators and auditors working more closely together."

He went on to talk about the evolution of the auditing profession:

"When I started my accountancy career in the ‘70s, values and ethics were dripped onto me." He added, "Under today's spotlight, that tone at the top needs to be even more visibly evident; with values and integrity literally dripping through an organisation...."

I wanted to share Sir David's remarks with you today, because I think you as educators have the first, best shot at instilling in young accountants the independence, objectivity and skepticism that will make them the professionals that investors are looking to.

An accounting undergraduate I spoke to recently expressed concern that his school had "taught him plenty about the mechanics of an audit, but had neglected to discuss at length the values an effective auditor must have."

He said professional skepticism and the auditor's duty to investors were never covered in-depth at any point during his time in school.

I think we can all do better, and I am glad that all of you are here today to help us, the PCAOB, do better.

In conclusion, let me suggest a few topics for you to consider:

As I have previously referenced, "How can we further improve audit quality and auditor independence, objectivity and professional skepticism in the context of an issuer pay model?

Whether and how does accounting and auditing affect a company's cost of capital?

What financial information do investors use when making investment decisions?

What role do investors want auditors to play with respect to the financial information they use?

Is an independent audit opinion on the financial statements still relevant to investment decisions today?

Should the auditing model switch to a continuous process rather than once-a-year reporting?

At what point should investors be warned of a potential going concern problem and how, if at all, should the current going concern standard be changed?

Is the audit firm pyramid structure — the up or out model — outdated and should the firm structure be flatter?

How, does one do an informative analysis of the costs and benefits of audit regulation? I know this issue will be discussed later tomorrow.

Are current accounting programs offered by our colleges and universities responsive to investor needs and adequately preparing accounting students to be effective auditors? And, how does one most effectively teach skepticism?